Cryptocurrency has been in the news lately, but while most people have heard the term, only some people understand what cryptocurrency is.
Cryptocurrency, or crypto for short, is a form of decentralized finance. Decentralized finance (DeFi) is a form of electronic currency in the form of coins or tokens.
These coins and tokens are not physical items. Instead, they are code that is recorded on a publicly shared ledger.
With traditional currency like the US Dollar, the currency gets its value based on the number of dollars in circulation at any given time and the value of the currency as it is traded against others.
Since the US government and central bank support the dollar, its value is partly due to the number of dollars in circulation and the perception of the strength of the US economy when trading against other currencies like the Canadian dollar, Peso, or British Pounds.
If you are reading this and wondering what is decentralized finance and cryptocurrency is, the two are interrelated but different.
Decentralized finance is a broad definition of a platform for financial transactions. With decentralized finance, it is typically an electronic form of finance that includes cryptocurrencies and NFTs.
Cryptocurrency is the electronic currency that DeFi operates and can take various forms, such as Bitcoin, Ethereum, and others.
With DeFi, no central authority regulates the amount of currency in circulation or provides a tangible item for determining value.
With DeFi, the value of the currencies is based on the perceived and agreed value between peers agreeing to a transaction.
Peer-to-peer value adds volatility as the currency’s value is based on the total amount of coins available and the demand that others have for the coins. For example, Bitcoin is a finite coin, and no more will be generated, which aids its value. At its peak, Bitcoin traded for over $65,000, making it the most valuable cryptocurrency in the world.
As people moved away from crypto, the value of Bitcoin took a beating, losing over 50% of its peak value in a short time.
For investors, that could be a disaster for their portfolios. Imagine buying Bitcoin at $40,000, watching it surge by over ⅓ in value, and drop by more than 50% within days.
That said, cryptocurrencies offer higher risk but much higher returns than traditional investments.
There are three typical ways to invest in a cryptocurrency that mirror similar investment strategies but have much more volatility associated with them than traditional investments.
To start investing in cryptocurrency, an investor would need to find an online trading platform or exchange and deposit fiat currency like dollars into an account before selecting a currency to invest in.
Buy-and-Hold
Much like traditional investing, where an individual buys a stock and holds it for years to gain value as it appreciates, crypto investors can buy-and-hold a coin as a strategy to sell once it gains much more value.
The strategy in DeFi is known as HODL, a long-standing joke originating from a typo.
With a HODL strategy, an individual is holding onto a currency regardless of the dips and peaks that occur during ownership.
It may take a person with either a disciplined strategy or a diversified portfolio to ignore the volatility and hold the coin for any duration.
NFTs
NFTs are short-hand for non-fungible tokens and are a form of digital currency that is part of the DeFi economy. An NFT can be anything that is unique and non-replicable, like individual works of art, songs, or any item that can be designed but not replicated.
The code that makes up the coin with cryptocurrency is limited to a certain amount. NFTs are unique lines of code that cannot be duplicated, making them more scarce than other coins and tokens.
The exclusivity of NFTs makes them more valuable than other forms of digital currency, making them more difficult to trade with others.
Since NFTs can’t be duplicated, the two parties need a smart contract that passes ownership from one party to the other to use them for a transaction.
Yield Farming
Similar to CDs and savings, yield farming is a form of passive investing. An investor would lock an idle token, perhaps loaning its value out to another party in return for an agreed rate of return.
Opposed to CDs, there are two significant differences. The first is that these investments are not insured, and two, the returns are not set by a central authority but rather by the market value at the time of agreement.
Investing in cryptocurrency is risky but also provides much higher returns. Understanding the basics and balancing out cryptocurrency as part of a diversified portfolio can lead to some incredible gains.
